The fixed income investment community has been shaken up by growing concerns over Greece’s creditworthiness, which appear to be spreading like a bush fire across eurozone peripheral states. While concerns over significant sovereign credit risk are currently limited to the euro area and Dubai, my colleagues at BMI believe that Latin American government credit, too, will come under more scrutiny over the course of 2010.

However, a recent Sovereign Risk Ratings assessment by the BMI Latin America team has found that in general, the ability of most Latin American governments to service their external debt obligations has improved on account of relatively robust economic recoveries seen in late 2009 and expected to continue over the course of this year.

Latin America differs from the eurozone and Dubai in three particular ways:

• Latin America has not seen construction booms of the magnitude seen in Dubai.

• Debt crises in the late 1990s and Argentina’s sovereign default in 2001/2002 have resulted in more conservative lending practices and, in turn, limited borrowing habits.

• As a result, sovereign or quasi-sovereign institutions did not have to absorb toxic debt to the same extent seen in G7 economies and the UAE.

What is more, the external position of most Latin American high-beta sovereigns is far more sustainable than the case of several European economies, where external debt is rivalling the size of the economy and current account shortfalls have traditionally been financed by reckless borrowing. That is not to say, though, that the region will not experience some of its own problems. Indeed, two of the most vulnerable economies, which stand out from the rest of the region are Jamaica and Nicaragua (see chart).

Latam External Risk Profile (Bubble Size = External Debt % of GDP)

These two economies have the highest current account deficits as a percentage of GDP in the region, and among the lowest foreign reserve cushions. What is more, their external debt pile as a percentage of GDP is around the 70% mark. Not surprisingly, therefore, Jamaica is already in talks with its creditors to find some sort of restructuring deal, and its willingness to assume highly stringent fiscal measures has paved the way for a US$1.27bn IMF Stand-By Arrangement this month.

Meanwhile, Nicaragua is far more precarious-looking, not least due to the nature of its polity and ominous signs that Nicaragua’s President Daniel Ortega would prefer to shun the international community than give up the public subsidies which have become critical to avoid an implosion of the economy and boiling over of already high social tensions. In short, BMI believes that out of Latin America, Nicaragua is the one to watch.

Meanwhile, Venezuela, though suffering heavily in BMI’s ratings, has bought some time by choosing to devalue the bolivar earlier this year, which has given the government of Hugo Chávez access to more funds in the near term. Generating most of its cash in US dollars, through state oil company PdVSA, each dollar now generates twice as many bolivars. Nevertheless, I have argued for some time now that Argentina stands to outperform Venezuelan debt over the medium term, once higher global oil prices and the effects of the devaluation run out of steam. Though Argentina’s government is still barred from international capital markets, efforts by the administration of President Cristina Fernández to reach a swap deal with outstanding creditors of the failed 2005 restructuring plan, and signs that the country is looking to mend ties with the IMF augur well for the country’s overall creditworthiness. That said, we caution that the dwindling political influence of Fernández and her husband Néstor Kirchner means that the couple’s increasingly controversial measures to raise the necessary financing to repay creditors (Fernández is currently trying to tap the country’s foreign reserves to pay down its external debt) may yet fail.

Venezuela Global US$ 2027 Bond, Yield

Nevertheless, as worrying as the situation may be, the government’s efforts to improve the country’s image with international creditors and the IMF should avert a full-blown (Greece-style) panic. Similarly, Venezuela continues to sit on vast oil reserves, which should also put aside a significant spill-over from the Greek tragedy. What is more, the decision to devalue the bolivar seems to be appeasing international creditors for now, with the country’s Global US$ 2027 bond rallying shortly after the announcement in January.

5-Year CDS Re-Indexed to Sep-08=100

Therefore, we believe that while some potential spots of bother exist in Latin America, the fallout from Greece’s (and potentially other peripheral eurozone economies’s) debt crisis will unlikely make it across the Atlantic. Risk Watchdog has re-indexed the contract for default protection on sovereign debt to just before the Lehman Brother’s collapse in late 2008 (see chart). This chart shows that while concerns over Greece have started to brew in late 2009, credit risk perception of Argentina and Venezuela has remained largely flat. Welcome to the new world!